Should you use home equity to buy a second home?
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For some homeowners, the cheapest cost of borrowing
isn't only about borrowing as much as possible at the lowest interest
rate. It's also about taking advantage of tax deductibility.
Take, for example, a newly married couple in which
both spouses come into the marriage owning their own homes. They
want to keep both houses -- renting them out -- and buy a third
house as their primary residence.
Tax deduction limits
"The trouble these people will run into is that a third home
is not tax deductible," says Dave Herpers, director of consumer
affairs for mortgage lender Amerisave. "Therefore, a third
home is an investment property." In fact, in the above example,
the spouses' original two homes are transformed into investment
properties, which means that the owners must contact their lenders
to tell them that the use of the property has changed, Herpers says.
"That lender would make the judgment call whether they have
to change the documentation surrounding their loan or refinance
If the owners must refinance, they move into complex
territory. They want to maximize the size of the mortgage on their
primary residence to take advantage of a lower rate and tax deductibility,
while refinancing the loans on the other two houses. This can require
delicate timing, if only to ensure that they qualify for all the
The cash-out refi shuffle
There is also the sensitive matter of staying within the letter,
if not the spirit, of the loan documents by engaging in creative
timing. In some cases, it might be possible to do a cash-out refi
while the house is still considered the primary residence, wait
a year, then rent out the home, without having to refinance again
at a higher investment-property rate.
Not every lender will go for that, says Bob Moulton,
president of Americana Mortgage Group Inc. "At the time of
application, you want to be as honest as possible with the loan
officer in terms of exactly how the property will be used,"
Moulton says. "Different lenders have different criteria and
some are restrictive or prohibitive of you renting the house out."
A cash-out refinance isn't the only way to extract
equity to buy a second house. You also can use money from a home
equity loan or equity line of credit. Rates on lines of credit usually
are below rates on fixed-rate mortgages.
Moulton has clients who owe $225,000 on a house worth
$1.5 million. They wanted to buy a condominium in the ski resort
town of Park City, Utah. So they got a home equity line of credit,
or HELOC, at a rate of less than 5 percent to buy and furnish the
condo in Park City.
The downside, Moulton says, is that the rate
on the line of credit is tied to the prime rate and can rise. But
his clients probably can handle any increase.